Micron's Patience Payoff
For Micron Technology (MU) - Get Report shares, it's been a long 12 months of steady declines, but the pain could soon be over.
That would be a relief to long-term investors in this memory-chip stalwart. Already in 2005, the stock is down 17% to $10.30 with much of that due to falling prices of DRAM (dynamic random access memory, which is used in most PCs) that are typical at this time of year. The declines have brought Micron shares near a 22-month low, and they now seem far away from an 18-month high of $18 struck in April 2004.
Indeed, Micron's fiscal second-quarter financial results next week should also reflect the seasonally tough quarter for its core DRAM market.
But these conditions should stabilize in the second half of the year as demand increases. In addition, other changes made by Micron to its product portfolio and manufacturing capabilities should provide the company with increased flexibility and leverage.
At the expense of its share in the volatile DRAM market, Micron consciously focused last year on building up its image sensor business, introducing its first NAND flash processor, investing more in pseudo-SRAM chips and devoting more capacity to next-generation DDR2 DRAM chips. Micron's costs last year also were affected by increasing production at a new state-of-the-art factory and by its efforts to develop its process technologies to make more efficient, less expensive chips.
Micron's base of non-DRAM chips -- which generate higher margins and sales -- now make up about 50% of its total sales.
The company expects these efficiencies to reduce bit costs by 10% to 15% in the second quarter and by around 8% to 10% for the next several quarters. Further improvements could come as its new factory in Manassas, Va., ramps to full capacity. However, these improvements come against a backdrop of declining memory prices, so the impact on gross margins won't be immediately felt. Margins are expected to fall sequentially in the second quarter.
The refocusing hasn't been kind to Micron's recent results. DRAM chips actually increased in price last year thanks to good demand and undersupply. As prices held firm, and market leader
Samsung Semiconductor
padded its top and bottom lines with DRAM proceeds, Micron missed its sales targets for its fiscal second, third and fourth quarters of 2004.
By the end of the calendar year, Micron had slipped from being the world's second-largest DRAM maker to third, trailing both Samsung and
Hynix Semiconductor
.
However, the benefits from product diversification and technology transitions should be more apparent in fiscal 2006, when the DRAM market is expected to shrink. It's for this reason that investors could see Micron as a play to navigate an upcoming memory chip slide. After all, it was the constant disappointment from last year and declining DRAM prices this year that have driven the stock to its current level.
"The timing was not that good for Micron last year," says Nam Hyung Kim, principal analyst of memory chips at iSuppli. "This isn't easy, but Micron is doing the right thing. They need to lower their risk structure associated with the volatility of DRAMs."
This isn't a brand new strategy, however. Samsung, the world's second-largest overall chipmaker, makes a wide range of memory products, claiming the top share not only in DRAMs, but also in NAND and SRAM. Its advantage is its ability to shift production lines from one type of memory to another to capture price discrepancies and supply/demand imbalances. Hynix, too, can shift production between DRAM and NAND.
"This is the way all memory suppliers should go," says Kim. "The critical things are how to manage your product portfolio in a smart way and maximize value to the company."
But it's not a zero-sum proposition. If all memory suppliers are more flexible with their production capabilities, then there should be fewer and less extreme periods of oversupply in the DRAM market. Ultimately, this benefits all of the industry players with more price stability and predictability.
For Micron, if it can start executing according to its plans and show that it's a more stable performer, regardless of what happens in the DRAM market, then the stock should respond positively.
Industrywide trends should help Micron, too. The largest DRAM vendors should benefit the most from more stable prices that generally occur in the second half of the year. Meanwhile, growing adoption of DDR2 chips, which will replace the current DDR standard in the mobile space, will also aid results. Samsung, for its part, expects to start selling more DDR2 chips than DDR chips in the middle of the year.
For its just-completed second quarter, Micron expects that overall average selling prices will decline between 10% and 15%, with bit and shipment growth of 15% to 20%, sequentially. Analysts have predicted earnings of 14 cents a share on sales of $1.22 billion, on average, according to Thomson First Call.
These estimates, however, revolve around a wide base due to the aforementioned unpredictability of DRAM prices. EPS estimates range from 5 cents to 26 cents, while third-quarter estimates range from a loss of 15 cents to earnings of 34 cents.
The early skinny from analysts looking ahead to Micron's earnings report is that they have noted the stock's slide and said that it has typically found a floor around its current level. With a price-to-book value of 1.27 and a price-to-sales ratio of 1.4, based on this year's consensus target, the stock is near historic trough levels.
Still, not everyone is comfortable picking up Micron's stock at these levels.
"I'd have to see something really happen, either price improvements for DRAMs or results from Micron that says something has happened to create a catalyst for the company, like production costs taking a quantum step down relative to everyone else," says analyst Lawrence Borgman with Ehrenkrantz King Nussbaum, who has no stake in Micron. His firm has no investment-banking relationship with Micron.
"I think a lot of people are apprehensive about what's going to happen because of the pricing situation," he says, adding that investing in any part of the DRAM market is dicey. "I try and stay away from commodity plays."